26 December 2010

PG: Look Ahead to December 2010 Quarterly Results

This post describes our model of Procter & Gamble's (NYSE: PG) Income Statement for fiscal 2011's second quarter, which will end on 31 December 2010.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about P&G and the business environment in which it is currently operating.

Procter & Gamble creates and markets many well-known Household and Personal products, which are Consumer Staples, to customers around the world.  The company, based in Cincinnati, traces its roots back to 1837.

P&G reported Net Income of $12.7 billion ($10.9 billion from continuing operations) on Net Sales of $78.9 billion in fiscal 2010, which ended in June.  Sales to Wal-Mart Stores (NYSE: WMT) and its affiliates produced about 16 percent of P&G's Revenue.

The company's market capitalization is nearly $200 billion, which makes P&G one of the ten most valuable U.S. corporations.

It's no surprise to find P&G on the list of S&P 500 Dividend Aristocrats.  The company has paid a dividend from 120 consecutive years, and it has raised the payment in each of the last 54 years.  P&G is also number 6 on Fortune Magazine's 2010 list of the World's Most Admired Companies.

P&G is organized into units that focus on a particular product category.  At the highest level, the company has three global business units:  Beauty and Grooming, Health and Well-Being, and Household Care.  Each GBU comprises two segments.

In fiscal 2010, the Household Care GBU generated about one half of P&G's net sales and the Beauty and Grooming GBU was responsible for about one third of sales.

The company's most-valuable brands, which are responsible for the lion's share of sales and profits, include Ace, Always, Ariel, Bounty, Braun, Charmin, Crest, Dawn, Downy, Duracel, Gain, Gillette, Head and Shoulders, IAMS, Mach3, Olay, Oral B, Pampers, Pantene, Pringles, Tide, and Wella. 

With such a broad product line, P&G has a lengthy list of competitors.  Colgate-Palmolive (NYSE: CL), Kimberly-Clark (NYSE: KMB), and Unilever (NYSE: UL) are a few of the better known rivals.  Consumer products compete at large and small retailers on price, quality, features, and marketing.  P&G has long been a top advertiser

P&G adds and divests brands regularly, generally aiming to strengthen growth, improve its return on capital, and exploit synergies.  The company acquired razor-legend Gillette in October 2005 for $57 billion.  P&G sold the Folgers coffee business in 2008 to J.M. Smucker (NYSE: SJM).  More recently, P&G sold its pharmaceuticals business to Warner Chilcott (NASDAQ: WCRX), and it acquired Ambi Pur, "a leading global air care brand," from Sara Lee (NYSE: SLE).

A fundamental aspect of P&G's strategy is to invest in Research and Development -- roughly $2 billion annually, conducted internally and externally -- to create innovative products deserving of premium pricing and brand loyalty

In the last decade, P&G has made an effort "to extend the availability and affordability of P&G brands to more low-income consumers, particularly in developing markets."  In 2009, 32 percent of the company's total sales were in developing markets, up from 20 percent ten years earlier.

P&G conducted its annual meeting with financial analysts on 16 December 2010.  The company noted that growth in developed markets was slow, and it could be negatively affected by rising commodity prices.

Procter & Gamble earned $1.02 per diluted share on a GAAP basis in the September-ending first quarter of fiscal 2011, down 4.2 percent from $1.06 in the same three months of last year.  Core earnings, a non-GAAP measure that excludes certain items and discontinued operations, rose from $0.97 to $1.02 per share.

Readers wanting to take another look at Procter & Gamble's September 2010 quarter might wish to review our Income Statement and Financial Gauge analyses.

Now, we are ready to look ahead to P&G results for the December 2010 quarter.

In the press release on 27 October 2010 announcing its results for the quarter ended last September, P&G updated its guidance for fiscal 2011 and addressed its expectations for the December quarter.

Fiscal Year 2011 Guidance

Net sales are expected to increase three to five percent in fiscal 2011. Organic sales are estimated to grow four to six percent. Unfavorable foreign exchange is expected to reduce net sales growth by approximately one to two percent. The net impact of acquisitions and divestitures is expected to be a neutral to one percent addition to net sales. Diluted net earnings per share from continuing operations and Core EPS are expected to be in the range of $3.91 to $4.01, up 11 to 14 percent on a continuing operations basis and up seven to nine percent on a core basis.

October - December 2010 Quarter Guidance

For the October - December quarter, net sales growth is estimated to be two to four percent. Organic sales are expected to grow three to five percent, reflecting continued, strong volume momentum, partially offset by mix and pricing. Unfavorable foreign exchange is expected to reduce net sales growth by about two percent. Acquisition and divestiture activity is expected to add one percent to net sales growth for the quarter. Diluted net earnings per share from continuing operations and Core EPS are expected to be in the range of $1.05 to $1.11, up four to 10 percent on a continuing operations basis and down five to up one percent versus prior year Core EPS of $1.10. The outlook for lower Core EPS is due mainly to higher year-on-year commodity costs and higher marketing spending as a percentage of sales.

A 2-to-4 percent growth rate, as cited above, for the quarter would translate into Net Sales, or reported Revenue, between $21.5 billion and $21.9 billion.  We are using the mid-range figure of $21.7 billion as our target for Revenue in the December quarter.

P&G's Gross Margin as a percentage of Revenue fluctuates from quarter to quarter.  In recent years, the margin has been slightly better in the December quarter than in the preceding September quarter.  Assuming a similar pattern, we are estimating the Gross Margin in the December 2010 quarter will be 52.5 percent.  Combining our Revenue and Gross Margin targets yields an estimate for the Cost of Goods Sold of (1 - 0.525) * $21.7 billion = $10.3 billion.

Sales, General, and Administrative expenses are typically between 30 percent and 33 percent of Revenue.  The rate in December quarters is typically close to bottom of this range.  This pattern has led us to select 30.8 percent as the target for SG&A in the December 2010 quarter, of 0.308 * $21.7 billion = $6.7 billion.

Assuming no special operating benefits or charges, the assumptions described above yields an estimated Operating Income of $4.7 billion, which is about 1 percent more than the comparable amount in the year-earlier quarter.

We expect net non-operating expenses of $200 million, and, therefore, pretax income of approximately $4.5 billion.

We're using an estimate for the effective income tax rate of 27.5 percent, which is somewhat lower than before because a greater percentage of income is being earned overseas.  This rate would lead to a tax provision of $1.2 billion.

Rolling up these figures, we're looking for Net Income from continuing operations of $3.27 billion ($1.09/share).  This is consistent with the company's guidance, and, perhaps, a little conservative..

In last year's December quarter, P&G earned $4.66 billion ($1.49/share).  Excluding income from discontinued operations, earnings were $3.15 billion ($1.01/share).

Please click here to see a normalized depiction of the projected results next to P&G's quarterly Income Statements for the last couple of years. [As a consequence of the sale of the pharmaceuticals business, P&G restated some historical financial statements to reflect the pharmaceutical results as a discontinued operation.  We used this information from the company to update our spreadsheets, making estimates where official data was not readily available.] 

Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: No position in PG at time of writing.

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